The Volatility Of Premiums

The stock premium, the annual average return of stocks minus the annual average return of one-month Treasury bills, has historically been high. This fact has, understandably, attracted investors to the stock market.

For the period 1927-2013, the stock premium averaged 8.18 percent. There has also been a size premium (the return of small stocks minus return of large stocks) and a value premium (the return of value stocks minus return of growth stocks) over that same period of 3.06 percent and 4.88 percent, respectively.

However, the excess returns are generally referred to as risk premiums—they aren’t free lunches. We see evidence of this in their volatility. The stock, size and value premiums have come with annual standard deviations of 20.29 percent (2.5 times the stock premium), 12.66 percent (4.1 times the size premium) and 12.79 percent (2.6 times the value premium), respectively.